Moving forward on mergers

Bank consolidation needs supportive reform

State Bank of India’s proposed merger of five associate banks and the Bharatiya Mahila Bank with itself is a welcome first step towards creating India’s first banking behemoth, which will be ranked 44th in the list of the world’s largest banks. The combined entity will have a balance sheet size of Rs 37 lakh crore, more than five times that of India’s second and third largest lenders. This only proves the point that India’s banking system is much too fragmented, and that policy emphasis should be on stronger banks which can support the investment needs of corporations and economic growth. The SBI merger will have many other benefits. For example, the cost of funds for the merged entity will come down by 100 basis points, because the deposits with the associate banks are taken at a lower rate. Also, the associate banks have Rs 4,000 crore fixed assets which will add to the capital of the merged entity.

A question that is likely to arise is what prompted SBI Chairman Arundhati Bhattacharya to change her mind so swiftly on the issue. Ms Bhattacharya, who sees “huge value” in the merger now, said exactly the opposite a few months ago when she said that the merger of associate banks was not a priority as there were far more important challenges ahead and that efficiency could be brought even without merging. That was the reason perhaps why the SBI itself went slow on a merger process suggested almost a decade back. Whatever be the reason for the change in position now, it would be a safe assumption that the finance ministry’s enthusiasm for banking sector consolidation must have had a rub-off effect. Ideally, the merger process should be initiated by banks themselves keeping in view the economies of scale that would accrue — but it’s hard to imagine any state-owned bank taking the initiative to present itself as a merger candidate. So a nudge from the ministry makes sense. But for any merger to be successful, it should be clearly understood by the stakeholders that the process will take time and should not be rushed through given the sensitivities involved.

Now that the move has been initiated, the bigger challenge is consolidation in the rest of the banking system. This is tricky given the huge challenges banks face, including the bad loan problem that has plunged many public sector banks in an unprecedented crisis. Also, since mergers are also about people, a huge amount of planning would be required to make the consolidation process smoother. Piecemeal consolidation will not provide a lasting solution and what is required is an integrated approach from all stakeholders including the government. For example, the government should stick to its earlier promise of performance-based capital infusion so that the weaker banks are forced to shrink their size and focus on niche areas, or what is technically known as narrow banking. The parameters that can be taken into consideration to decide on this could be stressed assets, capital adequacy ratio, return on equity and return on assets. The larger issue of reduced government ownership in public sector banks is another area where a hard look is required. Consolidation among state-owned banks is not a new idea; previous such initiatives had led to mixed outcomes.  It will need other, supportive reform this time.